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The 3 Numbers That Clip SIA’s Wings

SIALogoHave you ever wondered why Warren Buffett is so vehemently opposed to investing in airlines? He even once joked that if he gets an urge to buy an airline stock, he would call a toll-free number and say: “I am Warren and I am an aeroholic“.  And they would quickly talk him down.

Buffett has a point about airlines.

Airlines suffer from what is known as high operating gearing. This is different to financial gearing, which is all about leverage and borrowings. High operating gearing, instead, means that fixed costs form a big proportion of the business’ total costs. Put another way, an airline must recover all of its high overheads before it can start to make a profit.

In the case of Singapore Airlines (SGX: C6L) it is faring better than many other airlines but that is still not quite good enough. The Singapore flag carrier has over the last three years delivered a Return on Equity (RoE) that is below the market average.

Whilst the RoE for the 30 companies that make up the Straits Times Index (SGX: ^STI) is around 9%, SIA only managed to deliver a return of 2.4% last year.

SIA’s problem stems from its low Net Income Margin. At just 2.2% it is significantly below the market average of 19%. That said, SIA is doing better than, say, International Consolidate Airlines, which owns BA and Iberia. The European airlines Net Income Margin is minus 5.2%.

Interestingly, SIA is very good at making use of its assets. Its Asset Turnover of 0.6 implies that the company is generating 60 cents on every dollar of asset used in the business. The airline is also not too heavily leveraged. A Leverage Ratio of 1.7 is roughly in line with the market average.

By unpacking Singapore Airlines’ Return on Equity, it is easy to see where its problem lies. It’s disappointing RoE of 2.4% is the product of a low Net Income Margin of 2.3%; an acceptable Asset Turnover of 0.6 and an average dose of leverage of 1.7.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.